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Backwardation, can you explain it to me?

 -- Published: Tuesday, 18 August 2015 | Print  | Disqus 

By Bill Holter

  In the past, the topic of "backwardation" has come up and I've tried to write about and simplify understanding it.  We now have backwardation deeper and further out than anything we've seen in the past so it's time again to visit this anomaly. 

  What is "backwardation".  This is a situation in the futures markets where a product or contract's spot (current) price is higher than a future price (ie next month, 6 months or even 1 year in the future).  First, backwardation is very possible in many different commodities simply because of the timing of harvests for example in agriculture products.  For example, it makes sense a bushel of wheat might be more expensive in the middle of February as opposed to July-Sept. because this is when (in the U.S.) the harvest is done and the product is more plentiful.  If the supply is more plentiful, it follows (in the "old normal") that price should be softer.  Also, some sort of natural event can occur such as floods, drought, wildfires etc. which impact harvest or current supply.  In this instance, backwardation is perfectly normal and logical.


  In gold and silver however, backwardation should never happen, not for one second or even one penny.  This is because gold and silver are produced around the globe 24/7, it is not a seasonal business in other words.  Also, there is "theoretically always" above ground stock (vaulted metal ect.) to meet demand.  Gold nor silver should ever be worth more today than it is worth contractually a month from now.  This is so because the metal can be lent out and interest earned.  If current gold is worth more than future delivery, this would mean a lender of gold would be required to "pay interest" to the borrower.  This is the equivalent of having negative interest rates and makes no sense no matter how you look at (unless you are a panicky central banker).


  The current situation as of last night on the COMEX looks like this;   

Closing prices today; 8-17-15


August;         $1,112.90

Sept & Oct;   $1,112.40

Dec;              $1,112.70   


  As you can see, August gold is .50 cents more expensive than both September and October.  It is also more expensive than December.  The ONLY EXPLANATION can be one of two possibilities.  First, traders may fear a breakdown of the rule of law.  They fear they will not receive their contractually guaranteed delivery of metal in the future.  Call this "a bird in the hand" syndrome.  The other explanation is gold supply may be very tight and simply does not exist for current delivery.  Thus, "current" gold is worth more than future gold because it is needed now, right now!  Some traders may say "current prices are higher than future prices because market participants believe gold or silver will 'go down' so traders are just positioning themselves".  To this I say HOGWASH, traders would either sell the spot or go short, "contango" (higher future prices) must ALWAYS exist in gold because it is "money" and as such can be lent for interest.


  The above example displays what is happening on the COMEX.  If we look to London, the last I heard, current gold is $7.00 above the next future month.   In other words, a trader could "pocket" this $7.00 per ounce "guaranteed".  If this return is guaranteed, in today's almost 0% interest rate environment, why wouldn't the "profit" get locked in and taken via arbitrage?  Please don't tell me there is not enough money as traders will slit each others' throats for single pennies!  Arbitrage being ... sell the spot price higher than the future price (sell high, buy lower) for PROFIT?  Again, the answer I believe can only be because gold is either in short supply or traders are afraid of not receiving future delivery.  Arbitrage is not rocket science and has been done since the beginning of markets, in fact, in today's instant information age any "free money" like these trades should be scooped up before you can blink your eye ...but they are not! 


  We have looked at the situation of "waterfall" action in gold and silver many times over the last 2+ years.  How is it possible that "price" can go lower if the metal is in short supply?  If everyone "sold" and panicked as the charts depict, shouldn't gold and silver be spilling out of warehouses and vault ...and on to the streets?  Currently a very severe shortage exists in silver for current delivery (and has for several weeks), how is it possible if silver is scarce ...owners of said silver are trampling over each other to sell it?


  The answer of course is what we have told you all along,  the paper COMEX and LBMA markets have zero relationship to supply and demand in the real world.  In fact, if you want to "sell" paper gold or silver, all you need are "dollars" to post as "margin".  This farce may be coming to head.  Last month, "buyers" of real silver actually stood up and jumped in line to have July silver delivered to them.  This month, there are currently just over 15 tons of registered gold available for delivery yet over 18 tons are standing.  Will the 18 tons shrink?  Will the 15 tons be added to?  In the past this situation has worked out by month end.  Sooner or later it will not "work out".  This paper game is becoming ridiculously small in relation to the overall system.   The entire amount of gold available for delivery adds up to less than $500 million (lower case "m") while the system as a whole is dealing in the multi $ Trillions!


  Something is very wrong.  I was told years ago by a "famous" trader I was nuts regarding backwardation.  He told me it didn't exist on COMEX and LBMA didn't matter.  What possible explanation can be given for the current situation on COMEX (which supposedly "does matter") where backwardation clearly exists from the August contract all the way out to December?  I would love to hear theories on how the current backwardation is "normal" and or "it doesn't matter"???  I assure you it does matter and should not be ignored!


Standing watch, 

Bill Holter for;

Holter/Sinclair collaboration.

Bill Holter writes and is partnered with Jim Sinclair at the newly formed Holter/Sinclair collaboration.

Prior, he wrote for Miles Franklin from 2012-15. Bill worked as a retail stockbroker for 23 years, including 12 as a branch manager at A.G. Edwards. He left Wall Street in late 2006 to avoid potential liabilities related to management of paper assets. In retirement he and his family moved to Costa Rica where he lived until 2011 when he moved back to the United States. Bill was a well-known contributor to the Gold Anti-Trust Action Committee (GATA) commentaries from 2007-present.

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 -- Published: Tuesday, 18 August 2015 | E-Mail  | Print  | Source:

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